The impact of excise duty cut on petrol, diesel

Unless the government reduces its expenditure by the same extent, India’s gross fiscal deficit will be adversely affected by the excise duty cut on petrol and diesel. Graphic: Naveen Kumar Saini/Mint

Finally, there is some relief on petrol and diesel prices for consumers. The government cut excise duty on petrol and diesel by Rs2 a litre effective Wednesday. The timing of this move is particularly striking, considering that there has been much hue and cry on higher petro-product prices lately.

Back in 2014, lower crude oil price proved to be manna from heaven for the Narendra Modi government. It raised taxes and improved its fiscal position a great deal in the last two fiscal years. The accompanying chart has the details.

Of course, a cut in excise duty now would mean a loss to the government to that extent. It will have to let go of revenue worth Rs13,000 crore for the remaining part of fiscal year 2018 (FY18). But that’s not all. This cumulatively reduces the gross revenues by around Rs41,000 crore (0.25% of gross domestic product or GDP) including around Rs28,000 crore lower surplus transfer by the Reserve Bank of India, point out economists from Kotak Institutional Equities.

Needless to say, unless the government reduces its expenditure by the same extent, India’s gross fiscal deficit will be adversely affected. In other words, the government’s fiscal deficit target of 3.2% of GDP is at risk considering it has already stretched fiscal finances due to front-loaded spending for the first five months this year.

“We note that there could be a slippage of 25-70 basis points depending on the extent of revenue shortfall and expenditure pattern,” added Kotak in a report on 4 October. A basis point is 0.01%.

What about inflation? There will be a mild positive impact on inflation. A reduction in petrol/diesel prices will lower Consumer Price Index-based inflation by ~8-9 basis points in terms of the direct impact, wrote economists from Nomura Financial Advisory and Securities (India) Pvt. Ltd.

But a higher fiscal deficit will push up inflation. Ajay Bodke, chief executive officer and chief portfolio manager (PMS) at Prabhudas Lilladher Pvt. Ltd, says, “Higher-than- budgeted fiscal deficit would lead to additional budgeted borrowing in 2HFY18 and exert pressure on interest rates and inflation, further pushing back any hopes of revival of private sector capex and add to the earnings woes of India Inc.”

On the growth front, the excise duty cut would provide some boost to consumption as consumers will have some extra money as a result. But that is unlikely to move the needle much.

For oil marketing companies (OMCs)—Bharat Petroleum Corp. Ltd, Hindustan Petroleum Corp. Ltd and Indian Oil Corp. Ltd—the excise duty cut will mean some relief on the concerns over marketing margins. The pressure to reduce prices will be less on them now and hence, the development is sentimentally positive. It will be worth watching whether OMCs can raise their marketing margins.

Kotak Insitutional Equities’ calculations show that implied marketing margins on diesel have contracted by Re1/litre for OMCs since mid-September. According to Kotak, this may take some time to reverse, until global fuel price or exchange rate turns favourable, as OMCs may find it difficult to increase margins in the given scenario when the retail prices remain somewhat elevated and the government is being forced to cut excise duties, partly forfeiting its fiscal receipts from the petroleum sector. These stocks were trading higher on Wednesday.

So essentially after this excise duty cut we are left with increased risks to government finances and some possible gains for OMCs. The moot question then is why the government cut excise duty when those revenues were so helpful. Analysts don’t think global crude oil prices are set to increase sharply from a medium-term perspective. Simply put, oil prices are a huge political issue and the government has elections on its mind.